Should Americans Worry About Foreign-Government Holdings of Dollar-Denominated Assets?

Is there real reason for Americans to worry about the Chinese government buying and accumulating lots of dollar-denominated assets?

Probably not.

The U.S. economy is so massive compared to that of any other country that any government seeking to win influence over Uncle Sam by threatening to depress the prices of dollar-denominated assets would have to purchase and stockpile huge amounts of such assets. To accumulate such huge amounts the foreign government would have to tax its citizens heavily – so heavily, in fact, that sour economic consequences likely would befall that foreign country long before, and to a greater degree than, such consequences befall the United States. And such massive investments in dollar-denominated assets would make Americans noticeably wealthier and, hence, better able to withstand a sudden, politically induced negative shock to their prosperity.

Moreover, a massive sell off by (say) the Chinese government of dollar-denominated assets would further drain the Chinese government itself of huge amounts of wealth. As Richard Rahn writes[2] in today’s Washington Times,

Contrary to some scaremongers, the Chinese won’t suddenly sell all their U.S. government bonds, since those bonds provide much of their bank reserves. If they engaged in massive sales, they would drive down the price of the bonds, thus destroying their own banking system — and they know better than to do that. When the Chinese buy U.S. bonds, U.S. investors can put more of their capital into higher rate of return productive investments in the U.S. because there will be less U.S. government debt they need to finance. Thus, the Chinese holding U.S. government bonds benefits both China and the U.S.

Of course, perhaps the foreign government cares more about non-economic goals (say, influencing U.S. military policy toward Taiwan) than it cares about economic consequences. If we make this assumption, though, we must also hold open the possibility that the U.S. government cares more about certain vital non-economic goals than it cares about more narrow economic consequences. If, for example, Americans feel strongly that the U.S. military should help protect Taiwan from an invasion, then a threat from Beijing to dump lots of dollar-denominated assets on the market unless Uncle Sam promises not to protect Taiwan will not obviously work. What reason is there to suppose that the U.S. government is more apt than other governments to elevate narrow, short-run economic concerns above diplomatic issues, national-defense needs, and other important “non-economic” considerations?

Also keep in mind that the greater are a foreign-government’s holdings of U.S. assets, the greater is the potential leverage of the U.S. government over that foreign government. Most obviously – and most extremely – the U.S. government can default on some or all of its debt. Such a default will have serious harmful economic consequences for Uncle Sam (just as suddenly selling off its huge stockpile of U.S. Treasury securities would have serious harmful economic consequences for the Chinese government). But if we suppose that governments are especially prone to discount economic consequences in favor of the pursuit of non-economic goals, then the leverage which the debtor government gains over the creditor government perhaps looms as large as does the leverage that the creditor has over the debtor. In the end, it is impossible to determine which of these two governments, if any, has significant leverage over the other.